Start a business, Do your taxes, Save money

Expense or Capital Asset: Magic Rule #1

Remember that $2500 computer you bought last post? Well, I figure now is as good a time as any to talk about the difference between an expense and a capital asset.

Don’t panic. People always make this way harder than it needs to be.

A “capital” asset is just like a “capital” letter. In other words, it’s BIG. Bigger than your average, normal, everyday asset. And how do we define big? Why by $$$ value of course. This is business we’re talking about.

Let’s say I spend $50 on some ink for my printer. It may not be some big capital asset, but it is an asset nonetheless. It’s a little asset. How about a $0.50 pen? That’s a little asset as well. The Canada Revenue Agency recognizes that “little” assets like these are probably not going to last more than a year of normal use. And if they do, well CRA doesn’t care. Chances are, you’ll probably have to throw them away and buy another one before twelve months pass. Maybe several depending on what it is. And so, CRA allows us to “expense” these tiny assets completely on our tax return. This means we are allowed to decrease our income by the full amount we paid for these disposable assets in the same year we bought them.

But the CRA does care about those BIG assets (those Capital Assets). They know that if you spend a lot of money on something, you’re probably going to use it for more than one year. So they don’t allow you to deduct the full amount of the asset (“expense it”) in the year that you bought it. They will instead, only allow you to deduct a percentage of it, and this percentage varies depending on the asset.

For example, you can only deduct 30% of the value of a car, 4% of the value of a building, 20% of a fax machine, but at this point in time, 100% of a computer.

Holy cow! I thought this was going to be easy!

The truth is these percentages and categories change all the time, so let’s not waste any more time worrying about them. We’ll let our tax software at year-end tell us what we need to know. And if that doesn’t work, we might have to pay an accountant for the first year-end to figure out what category to put a certain asset in. But once we have that sorted out, we’ll be able to let the tax software calculate the percentage for all the following years.

I’m going to give you a magic rule for determining if something is an expense (a little asset) or a capital asset. But first, go back to your shoebox full of envelopes. Find a new envelope and write on it “Capital Assets”.

Magic Rule #1:

If it cost less than $400, call it an expense and put it in one of those envelopes you made after last post.

If it cost more than $400 put it in the “Capital Assets” envelope, if and ONLY if, you will still be able to use it next year.

In other words, if you spent $500 on pamphlets and you handed them all out, they would qualify as “Advertising Expenses” because you used them all up in the year. Even though you paid $500 for them, you would still put them in the “Advertising Expense” envelope.

So, the $2500 computer receipt would find a home in the “Capital Assets” envelope.

I LOVE TAXES. For 6 months of every year, I manage the Personal & Small Business Taxation Department of a Chartered Accounting firm. I file over 170 complicated Canadian tax returns for our clients every year. For the other 6 months, I am a fiction writer and small business consultant who helps his friends with their late-filed tax returns.

All content copyright 2013 James Swift

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